PRINCIPAL RESIDENCE EXEMPTION

Neufeld Legal PC: Chris@NeufeldLegal.com - 403-400-4092 / 905-616-8864

The Principal Residence Exemption is a key tax benefit for Canadian homeowners, allowing the homeowner to sell their primary residence without paying capital gains tax on the profit from the sale. To understand the Principal Residence Exemption, the core elements must necessarily be broken down and properly analyzed.

A. What is a Principal Residence?

To qualify for the exemption, a property must meet several conditions:

  • A Housing Unit: This can be a house, condominium, cottage, mobile home, trailer, or even a houseboat.

  • Ownership: You must own the property, either alone or with another person.

  • "Ordinarily Inhabited": The property must be "ordinarily inhabited" in the year by you, your spouse or common-law partner, or any of your children. This simply means you lived there at some point during the year, even for a short period.

  • Designation: You must officially designate the property as your principal residence for the years you owned and lived in it.

The exemption also applies to the land the housing unit is on, up to a maximum of a half-hectare (approximately 1.24 acres). You may be able to claim a larger area if you can prove it was necessary for the use and enjoyment of your home.

B. How the Exemption Works

The Principal Residence Exemption can either fully or partially eliminate the capital gain on the sale of your home.

  • Full Exemption: If the property was your principal residence for every year you owned it, the entire capital gain from the sale is tax-free.

  • Partial Exemption: If the property was not your principal residence for every year you owned it (for example, you rented it out for a few years or you have multiple properties and designated another one as your principal residence), you will need to calculate the portion of the gain that is exempt.

The formula for the exemption is:

CAPITAL GAIN

multiplied by

NUMBER OF YEARS DESIGNATED AS A PRINCIPAL RESIDENCE PLUS ONE

divided by

NUMBER OF YEARS YOU OWNED THE PROPERTY

The "PLUS ONE" in the formula is a special rule that allows you to claim the exemption on a second property for the same year when you sell your old home and buy a new one.

C. Important Rules and Considerations

  • One Property Per Year: A family unit (you, your spouse, and your unmarried minor children) can only designate one property as a principal residence for a given year.

  • Reporting the Sale: As of 2016, you must report the sale of your principal residence on Schedule 3 of your income tax return, even if you are claiming the full exemption. Failing to do so can result in significant penalties.

  • Change in Use: If you change the use of your property (e.g., from a principal residence to a rental property), the Canada Revenue Agency (CRA) considers it a "deemed disposition." This means you are treated as if you sold the property at its fair market value and immediately reacquired it. This can trigger a capital gain that you may have to report.

  • Property Flipping: New rules, effective January 1, 2023, state that any gain from the sale of a housing unit owned for less than 365 consecutive days is generally considered business income and is fully taxable, rather than a capital gain that would qualify for the PRE. There are some exceptions for life events like death, divorce, or job relocation.

For knowledgeable and experienced tax law representation for business succession planning and personal inheritance planning, contact tax lawyer Christopher R. Neufeld at Chris@NeufeldLegal.com or call 403-400-4092 (Calgary, Alberta) / 905-616-8864 (Toronto, Ontario).

Corporate Spin-off: Understanding and Objective Benefits
A corporate spin-off is a corporate restructuring procedure that enables the original corporation (the parent company) to separate out a division, subsidiary, or business unit to create a new, independent corporation (the spun-off company). The shares of this new spun-off company are then distributed to the existing shareholders of the parent company on a pro-rata basis. Read more.

 

Tax Evasion vs Tax Avoidance vs Tax Planning
Understanding the Principal Residence Exemption

NOT LEGAL ADVICE. Information made available on this website in any form is for information purposes only. It is not, and should not be taken as legal advice or tax advice. You should not rely upon, or take or fail to take any action, based upon this information. Never disregard professional legal advice or delay in seeking legal advice because of something you have read on this website. The law firm of Neufeld Legal PC would be pleased to discuss legal matters referenced in this website upon their retention in accordance with applicable requirements pertaining to client retention by this law firm. Thank you.